Afternoon analysis 06.10.2014

After significant moves in the previous week the dollar fell from its highs. Catalonia to perform the Scottish scenario. Further deterioration of investors' sentiment in the euro zone.

The previous week was marked by the significant dollar rally against its major pairs. This week started in profit-taking mood in the financial markets, what resulted in a strengthening of the euro and zloty.

Reports from the US were cause to the major market moves in last few days as data reaffirmed the strength of the economy. Especially the labor market data was very good – the unemployment numbers and ADP report on private hiring exceeded expectations. Moreover, the monthly employment situation report from Labor Department showed that companies added more new workers than projected and the unemployment rate fell below 6 percent for the first time in last six years.

The data increased a pressure on the Federal Reserve to drop its accommodative monetary policy. The Fed is expected to rise interest rates in the first half of 2015 for the first time since 2006. Conversely, the European Central Bank is moving in opposite direction. On last Thursday it announced asset-backed securities and covered bonds purchases as a measure to fulfill the range of tools used since June (record low interest rates and TLTRO allotment).

As a result, the dollar moved at highs against its major pairs. The EUR/USD hit September 2012 low. The USD/JPY rose at its highest since 2008. And the GBP/USD dropped at its lowest level since November 2013. Although today the dollar reversed from its highs, this moves is briefly due to short-term profit-taking and in the longer term the US currency is poised to rise.

Poor investors' mood

Sentix index – the gauge measuring investors sentiment in euro zone – dropped at its lowest since June 2013. The index fell for a third time to minus 13.7 points in October from minus 9.8 points in the previous month. It was below expectations for minus 11.8 points.

The report said that six-months outlook was deteriorated and there are no brights spots in the economic landscape. So it signaled increase of likelihood for GDP contraction in the euro area. Moreover, all composite indices were lower than in the previous month.

Additional poor data from the euro zone was released after the PMI reports showed drop of economic activity. Even the German PMI was below expectations, what reflected the growing concerns that major EU economy would fell into recession. The data on industrial orders released on the morning was clearly worse than projected (a wider view on that matter in our morning commentary).

Catalonia may follow Scotland

Spain may be forced to face Scotland-like crisis due to increasing support for independence vote in Catalonia – last Friday's polls showed 71 percent support for vote in the next month. Although Spain's Constitutional Court named the vote illegal, local authorities are going to proceed with referendum anyway.

The risk of political tensions may put the Spanish government in difficult position on reforms aimed at battling a 25-percent unemployment rate. Catalonia provides about 20 percent of country's GDP. So it will be very difficult – as it was with the Scottish possible secession – to decide on how to split public debt, tax revenues, currency and access to banking system and social security. In addition, increased risk may negatively weight on economic growth in the near future as it defers companies from investing and hiring.

Increased political risk influenced bond market. The Spanish 10-year bonds dropped. The risk premium – difference in yields against corresponding German papers – rose as much as 118 basis points in the last Friday. It was the highest since May 2010.

Zloty still stable

The Wednesday's Monetary Policy Meeting will be the most important event for the zloty. The MPC will decide on cutting the rates by 25 basis points and will announce additional cuts in the near future. The total amount of cuts will be 75 basis points until the end of fist quarter of 2015.

Today the zloty rose against the dollar and the euro, but an increase against the common currency is smaller that this against the US. It is due to risk-taking stance of investors. This will last for a short time and in we may expect return to trend observed in recent weeks – so the dollar is poised to rise against the euro and the zloty, and the Polish currency will be stable against the common currency.

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